The problems China faces in Evergrande are getting worse

For months, the breakup of China Evergrande, the world’s most indebted real estate company, has been like a slow-motion train crash.

After filing for bankruptcy protection last month — nearly two years after the company defaulted on payments to some creditors — Evergrande appeared on the path toward a debt restructuring more typical of creditors.

But its debts now exceed $300 billion, and any semblance of normalcy has disappeared. In a filing with the Hong Kong Stock Exchange, Evergrande announced on Thursday that authorities suspect Hui Ka Yan, the company’s billionaire chairman and founder, of criminal wrongdoing. The statement seems to confirm newscast Mr. Hui was under police surveillance, a form of house arrest by the Chinese authorities.

Once heralded as China’s largest real estate developer, Evergrande has paid the price for years of reckless borrowing and overbuilding after the Chinese government launched a tough debt crackdown to limit potential systemic risks from a real estate crisis.

Evergrande has become a symbol of the excess fueled by China’s real estate bubble. I have borrowed generously and spent generously. The company bought a football club and owned amusement parks, while Mr Hoey shuttled in a fleet of private jets.

But as Evergrande scrambles to finish construction of hundreds of thousands of pre-sold apartments and raise the funds needed to pay off debts to suppliers, the company’s future is now locked in China’s criminal justice system.

What’s happening in Evergrande?

Evergrande deals with two main issues.

First, the company is in negotiations with foreign creditors on a restructuring plan to settle more than $30 billion in distressed debt and other claims. But reaching an agreement has proven difficult, especially against the backdrop of declining real estate sales that are squeezing Evergrande’s cash flow.

Last week, Evergrande canceled a series of meetings with creditors, stating that sales “were not as expected” and that the company needed to re-evaluate “the terms of the proposed restructuring.”

Hengda Real Estate Group, Evergrande’s main unit in China, said in a filing on the Shenzhen Stock Exchange that it defaulted on principal and interest payments on $550 million worth of bonds due that day. Evergrande said over the weekend that it was unable to issue new debt due to the China Securities Regulatory Commission’s investigation into Hengda.

But Evergrande’s efforts to deal with its debt are now complicated by the second major problem the company faces: current and former officials are targets of criminal investigations.

Police in southern China said this month that public security officials arrested employees of Evergrande’s wealth management arm and imposed “mandatory criminal proceedings.” Chinese media also reported that authorities arrested the company’s former CEO, former CFO and former head of the company’s life insurance unit.

While Evergrande did not say much about the investigations into these former executives, it did confirm the investigation into Mr. Hui. He did not say what crimes were being investigated.

The company also said that its shares will not be traded until further notice. Evergrande stock has fallen 60 percent in the past two weeks.

How did Evergrande get into this mess?

Evergrande had humble beginnings as a home builder. Mr. Hui, a former steel mill worker, founded the company and oversaw its growth over a quarter-century into a real estate giant. Its dizzying rise was a byproduct of China’s urbanization drive, which led to a building boom fueled by massive amounts of debt to finance it all.

Like other real estate developers in China, Evergrande had a business model that was great when things were going well. It borrowed to build, then paid off the debt as homebuyers steadily snapped up properties. As Evergrande grew, and its residential buildings spread across China, the amount of debt also swelled. It branched out from real estate. It has built electric cars, run dairy, grain and oil companies, and even bought a football club.

But Chinese officials have grown concerned that real estate developers have become so big, and have borrowed so excessively, that if they were toppled, all that debt could drag the country’s financial system down. In 2020, regulators began making it more difficult for debt-laden real estate companies to continue borrowing. Evergrande’s business model – fueled by easy access to credit – has collapsed.

A year later, Evergrande defaulted on its debt. But the company continued to sell real estate and develop electric cars. It reported combined losses of $81 billion in 2021 and 2022 before finally succumbing to bankruptcy in August. The company said in its mid-year report that it lost an additional $5.3 billion in the first half of 2023.

Why are Evergrande’s problems important?

To be sure, Evergrande is not an isolated case. More than 50 Chinese real estate developers have defaulted or failed to make debt payments in the past three years since a government crackdown on excessive borrowing by real estate companies.

How Chinese officials handle the fallout from Evergrande may inform how Beijing will deal with other real estate developers facing similar dilemmas. Country Garden, once Evergrande’s main rival for industry supremacy, is also reeling.

The Evergrande region is also significant, given its size and the amount of debt it still carries. While some of this debt is owned by outside investors, most of it is in the hands of small or medium-sized companies – the backbone of the Chinese economy – that are still waiting to be repaid.

The company said last week that it still owes $82 billion to building materials suppliers alone. At a time when China is retreating, Evergrande’s unpaid bills are a drag that ripples through the economy.